S.E.C. Rule Curtailing Short Sales Will Stay

By Gerry Shih

July 27, 2009

The Securities and Exchange Commission expanded rules on Monday intended to provide investors more information about short sales.

The rules made permanent an emergency measure to discourage the practice of “naked” short-selling, a move that had been expected. Now Wall Street is closely watching the commission’s plans to require more disclosures on trades that involve bets that a stock’s price will fall.

Short-sellers trade borrowed shares of a stock, hoping to buy them back later at a lower price and pocket the difference. When a trader sells shares without borrowing them first, the practice is known as naked shorting.

Legislators on Capitol Hill have increased pressure on the S.E.C. to make a sweeping overhaul of stock trading regulations in the wake of the market collapse last year. Mary L. Schapiro, the chairwoman of the S.E.C., has said she is making the issue a priority. The agency said it was working with several self-regulatory organizations to expand disclosures about short-selling. For the first time, information on the volume of short sales involving an individual stock would be disclosed publicly on a daily basis.

A month later, the details of specific short trades would be disclosed, without the names of the investors who made the transactions.

Some traders say such a policy will handicap firms by allowing competitors to study patterns gleaned from the public data to figure out proprietary trading techniques.

After the chaotic days of last September, when bank stocks were plummeting, the commission passed a temporary rule requiring short-sellers to first locate the stocks they intended to sell, and then be able to have the shares on hand within three days or face a penalty.

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Mary L. Schapiro, chairwoman of the S.E.C., made the short-sale issue a priority.Credit...Jim Young/Reuters

The idea was that the rule would cut down on “failures to deliver” resulting from naked shorting  when short-sellers couldn’t deliver the shares they promised to buyers.

The nearly unanimous opinion, from Wall Street to Congress, has been that the ban on naked shorting was highly effective in curbing manipulation that has plagued the market for decades.

“It was a no-brainer,” said Joseph Saluzzi, co-founder of Themis Trading. “They’ve done a lot to crack down abusive shorting but it should’ve been done years ago.”

Some executives at publicly traded companies have complained that naked short-selling has allowed their shares to be driven below their true value. Officials from hedge funds, which often employ short-selling, have argued that wider problems caused the market turmoil.

“They’re making progress,” Senator Ted Kaufman, Democrat from Delaware, said of the rules in a telephone interview on Monday. “But there’s still no sense of urgency.”

Mr. Kaufman was a recent co-author of a letter urging the S.E.C. to enact additional requirements for brokers who want to sell stocks short. The senator said he would continue to lead a Congressional coalition pushing for an “uptick rule” that would allow traders to execute a short sale only after an increase or “uptick” in the stock price.

Still, the tougher rules are causing anxiety among some funds, which fear that regulatory fervor will lead to tough oversight against their favor.

“Any of the trading departments, any of the funds, would rather have less disclosure than more disclosure,” said Bill Schultz, the chief investment officer at McQueen, Ball & Associates, an investment firm.